Are you building a house? Learn the ins and outs of construction loans before you begin.
If you’re building a house, the home loan you’ll need is very different from a standard home loan. With a home loan for an established property, the entire loan is disbursed at settlement, but a construction home loan is a bit more complex.
Before you apply
Before you even apply for a construction home loan, you’ll need to provide different information than if you were simply buying an established home. While it’s easy to determine the price of an established home, it’s much more difficult to ascertain the cost of building a home.
When you apply for a construction home loan, you’ll need a copy of the building plans, which will need to be professionally drawn and fully costed. Once you have completed this step, your lender will assess the on-completion value of the home you’re building.
Work your builder doesn’t doAside from the work done by your builder, there may be other jobs you will need done to bring your home to completion. This includes landscaping, site works, connection to council utilities and add-ons such as swimming pools. The easiest way to handle this is to have your builder pay the contractors involved and include the costs in the construction contract. Should your builder be unwilling to do this, you’ll need to get detailed quotes from each additional contractor before you apply for your construction loan. Some lenders will only pay for additional contractor work upon completion, so make sure your agreement with additional contractors takes this into account.
You’ll also need to have a deposit for the land on which you’re building your home.
Once an assessment is complete, the size of your loan will be the lesser of either the valuer’s assessment of the on-completion value or the cost of the land plus the cost of construction. You should be aware that interest rates for construction loans are often significantly higher than for traditional home loans, so you will need to budget accordingly.
Should your builder be unable to estimate the cost of construction, you will have to apply for a cost-plus or variable-cost construction home loan. Be aware, though, that few lenders will give a loan for variable-cost building contracts.
Once you’re approved
Once you’ve been approved for a construction loan, you’ll need to take out a builders risk insurance policy. This protects both you and the lender is the case of storm or fire damage. You’ll need this policy even if your builder has liability insurance.
Unlike traditional home loans, the full amount of your loan isn’t paid in one lump sum. Instead, it is broken into several separate payments known as progress draws. These payments go to your builder, and cover different stages of the construction process. In most cases, there are five progress draws during the construction process:
- Foundations. This stage includes all the foundation and footing work for your home, including running plumbing into trenches before the slab is poured.
- Framing. This stage includes all the frame and brickwork for the house, as well as roofing and the first-fix electrical fittings.
- Lock up. This stage means the house is now sealed off from the elements and lockable. It includes window and door fittings, insulation and wall lining.
- Second fix. At this stage, kitchen benches and cupboards are installed, walls are ready for painting, second-fix electrical work and plumbing are done, wet areas are tiled and skirtings and cornices are fitted. On the outside of the house, guttering and eaves are completed.
- Practical completion. This stage includes finishing touches such as painting, walk-in robes and shower screens.
At each progress draw, your builder will send you an invoice. You will then send this invoice to your lender along with a drawdown request. Your lender will disburse the progress draw directly to your builder.
What about First Home Owner Grants?
First Home Owner Grants are available for the construction of new dwellings. Each state varies in its criteria for First Home Owner Grants.
The payment of a First Home Owner Grant for a construction loan varies from its payment for established properties. While the First Home Owner Grant is paid at settlement for traditional home loans, it’s paid at the first drawdown of funds for construction loans. This usually happens when the foundation is laid.
What if something changes during the building process?
It’s important to ensure that the building contract you present to your lender when you apply for a construction loan is the final contract. Should the contract change during the building process, your entire loan may need to be reassessed, and you may find yourself without the funds to complete construction.
If you find you need to change something during the building process that is likely to incur additional cost, it may be wise to pay for this out of your own pocket rather than trying to have your loan amount reassessed. If you lack the available funds to cover the additional cost, you may want to consider a personal loan.